Galen Stops examines the extent to which banks in different emerging markets face the same challenges when trying to build out their e-FX businesses, and questions the extent to which technology developments in these markets will follow a familiar pattern.
Talking broadly about how firms in emerging markets operate is often misleading, given the diversity of these markets and how widely the demands and conditions vary within each one. And yet, when it comes to banks in emerging markets that are looking to build out their e-FX businesses, there are some common themes that can be identified. For starters, these banks actually tend to have a sizable and often fairly diverse customer base, although each of these clients tend to trade FX on a smaller scale in terms of transaction size compared to their counterparts in more developed countries.
Banks in emerging markets are generally seen as customers of the larger banks, although it is notable that in talking to a number of sources across the world, there was near unanimous agreement that the larger, more international banks have pulled back from actually operating themselves in emerging markets to a significant degree. This could be part of a much broader re-assessment that has taken place within a number of these institutions about what FX activity is actually profitable enough for them, but it could also be a reflection of the fact that many have decided that going after the business of the small to medium enterprise companies in these regions is simply inefficient from a sales standpoint.
EM banks have expertise in their own currencies and are therefore expected to take principal positions when trading these, but are usually expected to operate in agency mode when trading G7 currencies, which they simply back-to-back with the larger banks.
Interestingly, one commonality that John Ashworth, CEO of Caplin Systems, sees amongst banks in emerging markets is that there is increasingly an expectation that they will offer some form of mobile banking to their clients.
“The more regional the bank, the more likely it is that the bank’s treasury customer will have his or her own personal banking, or mortgage, or savings account with that bank, and these smaller banks are quite good at having retail apps. What this means is that the customers are used to doing something – even if it’s just an account verification, or a payment, or checking their mortgage deposit – on a mobile device. And as a result, they often expect the treasury and capital markets division of the bank to offer the same. So whilst mobile is not being used for execution, there is an expectation that it will be offered for something, even if that’s just for notifications or watching orders,” he says.
Ashworth also notes that the smaller the overall FX market is in any given country, the more likely it is that the heads of FX for the banks there will function in a variety of other roles, meaning that when it comes to technology, the sales challenge is actually multi-asset class rather single asset class and it’s a relationship and customer management challenge rather than a product by product challenge.
In some emerging markets the fact that back office staff are cheap to hire means that there’s not necessarily a huge economic advantage in automating post-trade services. By contrast, there are advantages in automating the sales process on the front end because it’s costly to send relatively well paid salespeople around the different countries in each region to see very small customers.
“There’s a bit of a frenzy to get all of those customers wired up, not because they need to do it before the tier one banks send a local representative there, but because they want to get ahead of a disruptive payments provider coming in and showing them how to do foreign exchange in a totally different way,” says Ashworth.
In other emerging markets, however, banks are clearly feeling pressure to improve both their pre- and post-trade services.
“As regulatory requirements continue to increase, we are seeing greater emphasis on transparency, reporting and trade surveillance. There are definitely increasing demands for technology which helps meeting the pre- and post-trade reporting obligations in an efficient and cost-effective way,” says the head of e-FX at one Asian bank.
Likewise, Mpumi Makhubu, manager, e-FX products at Standard Bank, says that the increase in the number of clients that are trading electronically has naturally prompted and increased demand for more efficient pre- and post-trade services, and to achieve this, the bank has looked towards new technology.
“Clients expect post-trade services such as STP, and the provision of post-trade analytics for some transactions. Further to this, the traditional sales model has changed on the back of technological advancement in FX, where far fewer clients are relying on the dealing desks to execute trades on their behalf. This means sales teams and dealing desks also need technology that will enable them to have meaningful pre-trade conversations with high touch clients, such as providing guidance around best times and methods used to execute their trades, and guidance around TCA and best execution,” she says.
Returning to Ashworth’s point about the potential for disruptive providers to provide new FX solutions to emerging markets, some bankers certainly point to the influence of fintech firms in their e-FX build out.
The e-FX head at the Asian bank says that their firm has looked to fintechs to provide it with advanced technology and “real innovation”, enabling them to focus more on customer demands, trading strategies and the changing market regulations.
Meanwhile, a senior figure at one Mexican bank says that one of the advantages that they have found working with fintech firms is that they are able to provide them with more flexible and bespoke technology solutions for their market.
Indeed, Makhubu echoes the importance of factoring in local nuances when implementing technology in different markets.
“Often, technology is developed and tested with more developed and liquid markets in mind, and then provided to market makers in less liquid markets without factoring in their nuances. Technology can enable regional banks to be more effective by considering the contexts and nuances in which these market makers operate. Assumptions made from developed markets such as low latency, and deep liquidity need to be revised for these markets, and more focus should be placed on ensuring technology enables stability and agility,’ she explains.
Implementing new technology in more emerging markets is not without its friction points though. Some of these are internal – at a Profit & Loss Latin America conference in Mexico City, a representative of one bank once explained that part of the challenge for them to introduce any new technology was that they had to sell it to the people above them who write the cheques and are often reluctant to do so for technology that is unproven within the bank; as well as the sales people below them, who are concerned that the introduction of technology will erode their relationships with clients and render them obsolete.
“That issue is never going to disappear,” concedes one technology provider that operates in the Latam region. “Just the initial onboarding and getting everything signed off is always going to remain a challenge. But what you have to do is just demonstrate the value-add of the technology and and the cost savings it can achieve and then it can become a very compelling case for these banks.”
Other challenges are external. The e-FX head in Asia cites “everchanging regulation” as a major friction point for them with regards to implementing new technology. In addition, they highlight the difficulties associated with finding the right technology talent, particularly at a time when employers are facing increased competition from non-banks, fintechs and other banks.
For Makhubu, one challenge that Standard Bank has faced is the ability to influence quicker adaptation to new ways of working and quicker adoption of new technologies. The bank has implemented a “modularised” approach to sourcing or building the technology it needs, in most instances opting for technology that is customisable.
The advantage of this is that it has enabled the bank to build its e-FX business based on its requirements for efficient sourcing of liquidity, price formation, optimal distribution, and finding the most efficient risk management tools considering its context and the nuances of its local market. The downside is that this modularised approach has meant that integrating these new technologies has been challenging and costly.
In addition, Makhubu notes: “Introducing new technology also means replacing older legacy systems which involves switching costs, and so we’ve had to very carefully consider which technologies to introduce having these costs in mind. Another point of discussion we have had is whether to build or buy where we have had requirements for new technology. This is an ongoing conversation as we continue optimising our business and developing our competencies and key focus areas.”
Regardless of the challenges though, it is inevitable that technology will continue to shape FX trading in emerging markets, but one key question is whether these markets will develop along familiar paths or whether the technology will take them in new directions.
For example, in some of the more frontier markets with very high growth rates, particularly in Africa, Ashworth sees the potential for financial firms to leapfrog past using traditional desktop systems and go straight towards using a mobile or tablet device instead.
“As these economies grow rapidly there is the opportunity to have a new and disruptive process to equip that economy without having to go through the more legacy, more traditional, way of doing things,” he says.
Ultimately, however, Ashworth sees more of a trend towards replicating the technology that exists in more developed financial markets, precisely so that firms in emerging ones can interact with these markets more effectively.
“The reason that these markets are “emerging” is because they have some form of growth driver, such as commodities, natural resources or manufacturing capabilities. This in turn drives a demand for world trade with firms that are – by definition – elsewhere. So these emerging market firms generally look to match, copy and conform to what exists elsewhere rather than reinvent the wheel. So on the one hand, it would be easier to disrupt an emerging economy with new technology, but on the other hand, companies in these economies can be quite conservative with new technology because they want to copy what the counterparties that they trade with in other markets have in place,” he explains.
Evolving Client Demands
It’s also true that bank e-FX requirements in emerging markets are driven in turn by the evolving demands of their client base, and in many cases these demands have a familiar ring to those used to dealing in more developed markets.
Makhubu says that client e-FX demands in the last few years have generally been fairly basic in that they only require an electronic platform on which to execute their FX, or leave their FX orders. She says that Standard Bank’s eMarket Trader single-dealer platform has been great in fulfilling these needs, highlighting that the percentage of its South African clients that executed over electronic channels jumped from 25% in 2016 to 70% in 2017.
“Some clients demands have begun to evolve as more are asking for more sophisticated tools such as algo execution tools. We are constantly looking to give our clients the best experience and journey, and provide fit for purpose tools to enable this,” adds Makhubu.
By contrast, the bankers in Mexico and Asia point to the growth of technology solutions that increase pricing competition in their respective markets. In Mexico, the growth in the sophistication of aggregation solutions and the simultaneous decrease in cost of accessing these solutions has apparently increased the amount of potential liquidity providers in the market and helped local banks become more active market makers to local clients and counterparties.
Meanwhile, the Asia e-FX head comments: “There is a shift from single-dealer platforms to multi-dealer platforms as clients are more pricesensitive and it’s commonly required to prove that executions are done on the best prices. There is still demand for single-dealer platforms, but clients are expecting more relationship-centric functions such as research materials and advisory products.”
So although client demands in these regions differ somewhat, as previously stated, both stages of FX market evolution will be familiar to long-time industry observers. The fintech boom that has taken place in recent years adds an interesting element to the development of these markets, and there is certainly room for disruption in certain areas, such as payments. But when it comes to the development of core e-FX businesses it seems likely that the real role of fintechs will be to offer banks and other financial institutions technology solutions very similar to those that exist in more developed markets, but at a lower price point and with greater flexibility to adapt to the nuances of their local market.